The Perils of Managed Trade

by Susan W. Liebeler and Michael S. Knoll

Susan W. Liebeler, former chairman of the International Trade Commission, is a partner in the law firm Irell & Manella. Michael S. Knoll, a lawyer and an economist, is an assistant professor at the University of Southern California Law School and of counsel to Irell & Manella.

Executive Summary

From Capitol Hill, Wall Street, the Great Plains, and
Silicon Valley have come proposals to abandon the multilateral
trading system and begin managing trade from Washington.(1)
A move toward managed trade--substituting government intervention and market-share goals for market forces and multilateral rules--would represent a change in policy for the
United States, which since the end of World War II has been
a leading advocate of liberalizing international trade.

Advocates of managed trade often refer to it as "strategic
trade" and "industrial policy" in an attempt to create the
impression that adopting such a policy would be wise. American
public opinion is being swayed by that rhetoric. A survey
by the American Insight Group found that well-educated, high-
income Americans, who have traditionally been the most receptive to free trade and foreign investment, are beginning to
favor an aggressive U.S. trade policy, especially toward
Japan.(2)

Moreover, as Jeff Faux, president of the Economic Policy
Institute, a liberal think tank, noted, the U.S. government's
progression toward an industrial policy "is probably going
at a faster pace than it would have had [Michael] Dukakis
been elected."(3) The government has already approved subsidies for manufacturers of semiconductors and high-definition
television, and Congress and the Commerce Department have
forced renegotiation of the FSX fighter deal with Japan.

The argument that the United States should adopt managed
trade always involves Japan and frequently boils down to no
more than the following: Japan, which manages trade, is doing
very well economically, so managed trade must work. The advocates of managed trade overlook Japan's high savings rate,
long work week, low illiteracy rate, and relatively modest
government spending. In addition, they ignore the many countries, including most of the Eastern bloc, whose economies
have been strangled by central planning.

We should be wary of jumping to the conclusion that
Japan's economic successes have been the result of managed
trade and its powerful proponent, the Ministry of International
Trade and Industry. Although some industries supported by
MITI, such as semiconductors, have succeeded, other MITI
projects have failed. For example, the aluminum-smelting
industry, which MITI nurtured, has practically disappeared
from Japan.(4) In addition, some of Japan's greatest commercial successes are firms that entered new markets even though
MITI tried to hold them back.(5) Honda and Sony are good
examples. It is therefore not clear whether Japan's economic
miracle occurred as a result of MITI, as some in the United
States believe, or in spite of MITI, as some in Japan believe.

Even if we concede that MITI has generally been successful
in promoting Japanese industries, it does not follow that the
United States should adopt similar policies. Only if we
believe that such policies would promote our national interest
should we adopt managed trade. If managed trade is to be an
effective policy for the United States, it must not become
another income-support program for politically well organized
protection-seeking interests. In light of the debate surrounding extension of the voluntary restraint agreements on
steel, which were more a matter of politics than of economics,
it seems unlikely that the United States would avoid that
trap. Managed trade, in whatever guise, would probably do
more harm than good.

Trade Imbalances

Many of the calls for managed trade are motivated by
concern with the U.S. trade deficit, which was $114.9 billion
in 1989. The largest U.S. bilateral deficit in that year
was $49.8 billion with Japan. Not surprisingly, Japan is
the object of most proposals for managed trade.

Americans tend to associate bilateral trade deficits with
unfair trade practices, but in a multilateral trading system,
there is no reason for bilateral trade figures to zero out.
Why should the United States' demand for imported automobiles
and shoes exactly equal South Korea's demand for imported
hides and aircraft?

The authors have run deficits with their local grocery
store for many years. They have been able to maintain a trade
relationship with Giant Food by paying their grocery bills with
money, not legal services. Giant Food, in turn, runs much
larger deficits in its trade relationships with its suppliers,
such as Paul Newman and Frank Perdue. The same principle
applies to countries; there is no reason for bilateral trade
flows to be equal.

Another widespread belief--typically manifested in
rhetoric about "level playing fields"--is that the United
States is experiencing bilateral trade deficits because its
markets are open to foreign competition whereas other countries' markets are closed to U.S. competition. However, the
evidence of both the openness of our markets and the protection
of foreign markets is ambiguous. For example, the average
tariff rate on Japanese imports is comparable to the average
tariff rate on U.S. imports.(6) Moreover, the value of U.S.
exports to Japan increased rapidly in the 1980s. The growing
bilateral trade deficit with Japan is a result of an even
more rapid increase in the value of imports from Japan.(7)

A recent Federal Trade Commission study concludes that
the United States has completely reversed the progress toward
multilateral free trade that had been made since World War
II. As a result of the proliferation of nontariff barriers
to trade, which include quotas such as those on steel and
textiles, the U.S. economy is less open today that it was in
1946.(8)

The U.S. trade deficit is the result of macroeconomic
conditions and policies, not unfair trade practices. The
low U.S. savings rate and America's recent tendency to spend
more than it earns have produced a large influx of capital,
a correspondingly large trade deficit, and a number of bilateral trade deficits.

Policy Proposals

In recent years there have been several proposals for
cutting the trade deficit with Japan, all of which are based
on the erroneous assumption that a bilateral trade deficit
is a serious problem.

Advisory Committee Recommendation

The Advisory Committee for Trade Policy and Negotiations,
originally established by the Trade Act of 1974, composed
primarily of CEOs of large corporations, and chaired by James
D. Robinson III of American Express, recognized the important
role macroeconomic policies play in the U.S. trade deficit
with Japan but nonetheless recommended a variation on the
theme of managed trade.(9) The advisory committee recommended
that U.S. negotiators calculate what U.S. market shares would
be in competitive, barrier-free markets and then push the
Japanese to implement policies that would produce those market
shares. Although the advisory committee's recommendation is
only for trade with Japan, it could be applied to other countries.

For the advisory committee's approach to work, the U.S.
government would have to be able to estimate market shares
with reasonable accuracy. Although it might be possible to
compare the production costs of simple commodities, such as
wheat, and then make intelligent estimates of market shares
in competitive, barrier-free markets, conducting such an exercise for differentiated products and more complicated market
structures would be far more difficult. No one knows how to
estimate the competitive market shares for such industries as
telecommunications and semiconductors. Given the inexactness
of such estimates, substantial disagreement over "appropriate"
market shares would probably arise.

Implementing the advisory committee's approach might well
cause even more suspicion and hostility than we now face. That
risk would be greatly increased by the possibility that the
negotiating agencies would be captured by exporting firms
seeking larger and larger foreign market shares, regardless
of economic efficiency. If the advisory committee's recommendation were implemented, export firms would have the same
strong incentives to spend time and money guaranteeing export
shares that import competing firms already have to lobby the
government to protect and expand their domestic market shares.
Moreover, the United States would probably generate less
hostility by limiting foreign exporters' U.S. market shares
than it would by imposing U.S. exports on other countries.
The latter policy would force them to confront the results
of America's political bullying daily.

Enforcing market shares would also be a problem. Although
MITI, for example, has a great deal of influence in Japan,
it cannot force Japanese companies to buy U.S. semiconductors.
To enforce a U.S. share in the Japanese semiconductor market
of, say, 20 percent, without buying the semiconductors itself,
MITI would have to be able to compel Japanese companies to buy
U.S. semiconductors. The Japanese government could only
accomplish that if the Japanese economy were centrally planned--
the same type of planning that ruined the economies of the
Eastern bloc countries. Such a solution would certainly
reduce Japan's trade surplus to the United States, but it
would also have many undesirable consequences for Japan and
the rest of the world.

Even if the market-share targets were met, they would not
be met by expanding trade. Foreign countries, responding to
U.S. pressure, would probably redirect their purchases from
more efficient but politically less powerful suppliers to
suppliers backed by the political clout of the U.S. government. In the words of Jagdish Bhagwati, a professor of economics at Columbia University, that would produce "a world
economy in which the politically powerful nations would expand
their exports to weaker nations at the expense of less powerful
but more efficient rivals. The overwhelmingly likely outcome
then would be a proliferation of voluntary import expansions--
discriminatory, quantitative commitments by specific countries
to increase imports from the United States."(10) Such trade
would be neither free nor fair.

The Kissinger/Vance Proposal

Another version of managed trade was proposed by former
secretaries of state Henry Kissinger and Cyrus Vance. Their
proposal, which, like the advisory committee's, was aimed at
Japan but could be applied to other countries, calls for the
United States and Japan to establish an overall trade balance
with which both countries are comfortable. To achieve that
balance, Japan would be permitted to choose which exports to
reduce, which imports to increase, and the amount of reduction
or increase.(11)

Just as war has been called too important to be left to
generals, the Kissinger/Vance proposal suggests that trade is
too important to be left to secretaries of state. The proposal
is at first glance an appealing diplomatic solution because
it allows maximum flexibility to be used to achieve a desired
result. However, Japan would be very unlikely to open its
market to U.S. exports. Instead, Japan would restrict exports,
raise prices, and blame the United States for the results.

The Kissinger/Vance proposal would be a reprise, on a
broader scale, of Japan's voluntary export restraints on
automobiles. As a result of those restraints, which were
implemented in the spring of 1981 in response to U.S. pressure,
Japan sold fewer cars in the United States, but the cars it
did sell were generally more luxurious models, loaded with
options, that carried substantially greater markups.(12)
Export restraints can cost U.S. consumers plenty.(13)

The Kissinger/Vance proposal would permit Japan to limit
exports to the United States in precisely those areas in which
Japanese firms can earn the greatest monopoly profits and thus
harm U.S. consumers the most. The Federal Trade Commission,
the Department of Justice, and a number of state agencies
enforce antitrust laws. They devote substantial resources
to detecting domestic monopolies and cartels and preventing
their formation. Yet the Kissinger/Vance proposal would
encourage foreign producers to act as monopolists in the
U.S. market.

The Baucus Proposal

Sen. Max Baucus (D-Mont.) introduced a bill (S. 292) in
January 1989 that called for the president to negotiate sectoral agreements, similar to the 1986 Semiconductor Arrangement
with Japan. The Semiconductor Arrangement has resulted in
higher U.S. prices for semiconductors and increased U.S.
employment in their production, as its proponents hoped it
would. However, an unintended but foreseeable result of
raising the U.S. price of semiconductors was to reduce employment in the larger computer and computer workstation
industry.(14)

The Semiconductor Arrangement has also hurt U.S. competitiveness in the computer industry. Many Japanese semiconductor producers also make computers; the Semiconductor Arrangement did not force those integrated producers to raise
their internal prices for semiconductors. Because many
Japanese computer manufacturers were able to buy semiconductors
for less than their U.S. competitors could, the Semiconductor
Arrangement made it possible for Japan to compete more effectively in the computer market, which had traditionally been
dominated by U.S. firms.(15) The Semiconductor Arrangement
is hardly a model for U.S. trade policy.

The Key Sectors Approach

Another argument for managed trade is based on the assumption that there are "key sectors" of the economy that
are supposed to have linkages with other sectors. Loss of
key sectors is supposed to produce a ripple effect, as related
sectors contract and shrivel up. Conversely, when key sectors
are nurtured and permitted to grow, they allegedly create
benefits throughout the economy, as related sectors grow.
The decline of certain elements of the U.S. electronics industry, especially televisions, VCRs, and semiconductors,
is usually cited in support of the key sectors theory.(16)

Perhaps the best known argument for the existence of
key sectors comes from the "deindustrialization" or "manufacturing matters" school of thought once made popular in
Great Britain by the economist Nicholas Kaldor and now espoused
by two modern Americans, Stephen Cohen and John Zysman of
the Berkeley Roundtable on International Economy. As the
title of their book, Manufacturing Matters: The Myth of the
Post-Industrial Economy,(17) suggests, Cohen and Zysman consider manufacturing a key sector.

The basis for their argument is that there are linkages
between manufacturing and the rest of the economy. According
to Cohen and Zysman, because of those linkages, it is unlikely
that the United States can move from a manufacturing to a
service economy, as some have argued.(18) They believe the
United States needs to maintain a strong manufacturing sector
if it is going to develop a strong services sector. Cohen and
Zysman argue that the United States is deindustrializing,
which they claim presents a serious threat to our economic
well-being. They recommend that the United States adopt a
policy of managed trade to foster reindustrialization.

There are two major problems with Cohen and Zysman's
argument. First, it is not clear that U.S. manufacturing is
in trouble. Productivity growth in manufacturing was very
high in the 1980s,(19) and as Robert Lawrence has shown,
manufacturing's share of the U.S. gross national product has
remained roughly constant for several decades.(20) Faced
with those conclusions, Cohen and Zysman look for other evidence to support their case that manufacturing is
declining.(21) Their reluctance to support their assertions
with statistical tests and consistent economic analysis led
Bhagwati to conclude that "manufacturing may indeed be in
trouble in the U.S.; but the authors do not provide a plausible
analysis as to how and why."(22)

Second, the existence of linkages between various sectors
does not imply the existence of external benefits to other
industries, which economists call externalities. As noted
below, the existence of externalities provides at least a
theoretical basis for managed trade. The existence of linkages
that are not externalities does not.

The New International Economics

Avinash Dixit, Jonathan Eaton, Gene Grossman, and Paul
Krugman are among the economists who have begun to integrate
the fields of international economics and industrial organization. They start not from the pure competition view of
markets found in classical economic theory but from the imperfect competition models of modern industrial organization.
Under such market conditions, managed trade can be justified
as an instrument of national policy because of "profit shifting." Managed trade allows a nation to increase its national
income by shifting profits, or in economic jargon "rents,"(23)
from the oligopolistic industries of other countries to itself
through the use of such instruments of managed-trade policy
as government subsidies.

There is, however, a big step between theory and policy.
It is one thing to conclude in theory that a policy of managed
trade could benefit the nation. It is a very different thing
to conclude that a particular policy for a particular industry
would benefit the nation. Krugman has identified four major
questions that must be satisfactorily answered in order to
justify the use of managed trade in any particular
instance.(24)

Can Key Sectors Be Identified?

The first question is whether key sectors can be identified. That would be a difficult enough question to answer
ex post; given the current state of knowledge, it may be
impossible to answer ex ante. Economists have suggested two
criteria for determining whether a sector is key: the existence
of rents, which are likely to take the form of unusually
high returns on capital or labor, and the existence of positive externalities. Both criteria are related to raising
national income, or increasing the size of the "economic
pie."(25) A sector that meets either of those criteria is a
key sector.

Rents. In testing for the existence of rents, one cannot
simply look for high wages. Wage differences in an industry
can reflect a host of factors unrelated to rents. Workers
who are paid more because they are highly skilled or endure
harsh working conditions, for example, are not earning
rents.(26)

One cannot concentrate on the winners and ignore the
losers when testing for the existence of rents. What appears
to be an exceptionally high profit from an earlier investment
in research and development might well be a normal rate of
return on a risky investment. Although some investments in
R&D produce tremendous returns, many large investments yield
nothing. Firms will invest in R&D only if the returns on
products that succeed are large enough to cover the losses
on products that fail. Therefore returns to an industry
from R&D can be assessed only by considering the failures as
well as the successes. Only industries that are earning
abnormally high profits after the risk of failure is taken
into account are earning rents.(27)

Simple luck is a related problem. Because of shifting
demand, technological developments, or political events, the
capital and workers that are already in certain industries
may earn unusually high rates of return. Such windfalls,
however, do not accrue to new entrants. There is thus no
reason to use government policy to encourage entry into such
sectors.(28)

Even if industries in which capital and labor have historically earned abnormally high returns could be identified,
a policy of managed trade would not necessarily be warranted.
If a policy is to encourage R&D in certain sectors, the sectors
must be identified in time for effective government action
to be taken, usually before their products reach the market.
That is likely to be more complicated than identifying such
sectors after the fact.

Externalities. Not all linkages imply positive externalities. Externalities are found only in linkages in which
there are no established property rights and thus no market
prices. It is frequently argued that much technological and
business information is an externality because firms in one
industry benefit from knowledge generated in other industries
without paying for it.(29)

For example, advocates of federal support for high-definition television assert that subsidizing development of
a domestic HDTV industry would have large spillover effects
on the domestic electronics industry, especially on semiconductor and computer producers. However, determining whether
such effects are externalities is difficult because externalities, by their nature, do not produce a paper trail for
economic investigators. There have been a few historical
studies of externalities, but predictive studies are needed
to inform trade policy.

Is There a Policy Instrument?

The second question that policymakers should address
when deciding whether to adopt a policy of managed trade is
whether there is a policy instrument that could promote the
desired goals. The real problem here is insufficient knowledge. For policymakers to encourage key sectors, they must
be able to predict the results of their policies, which often
depend on the nature of competition within an industry.
For most industries for which managed-trade policies have
been recommended, the relevant markets cannot be characterized
as "perfectly competitive." Those industries do not operate
with many small producers who make identical products. Product
differentiation and learning curve effects complicate matters,
and of course, the effects of government intervention are
much more difficult to predict with complex market structures
than with simple ones. Many economists find making such
predictions so daunting that they are unwilling to experiment,
at least for the present.(30)

Would Decisions Be Made Properly?

The third question is whether policymakers would be
able to make the correct and sometimes tough decisions by
acting on the basis of economic evidence, not politics. As
the above discussion indicates, identifying key sectors is
difficult. In part, the difficulty reflects the current
state of economic knowledge, both theoretical and empirical.
Although further research is likely to increase our understanding of complex international market structures, identifying key sectors and formulating appropriate polices are
likely to be extremely difficult tasks for a very long time.
Whether the federal government could perform those tasks
competently is therefore an important consideration.

Industries that stand to benefit directly from managed-trade policies, which usually entail protection from imports
or government subsidies, are likely to advocate them even if
they would not benefit the nation as a whole. Policymakers
would have to be on the lookout for industries that invoked
the economists' argument that a policy of managed trade can
have legitimate uses in an attempt to justify income-support
policies for their own benefit. Robert Lawrence of the
Brookings Institution described the possibility of political
considerations swamping economic ones:

Managed trade is simply a bad idea. It replaces
competition among firms with competition among
bureaucrats. The division of powers in the
U.S. political system is particularly ill-suited
to managing the details of the economy. In
the United States any attempt to divide up the
pie would not be based on strategic economic
and trade criteria. Rather, it would be based
on political trade-offs that would reflect
lobbying skills and masquerade under the rubric
of fair shares.(31)

How Would Other Countries Respond?

The fourth question that must be asked is how other
governments would respond if the United States adopted managed
trade. Some believe that the adoption of an aggressive and
across-the-board policy of managed trade would increase our
nation's credibility in trade negotiations. Others believe
that retaliation and a breakdown of the multilateral trading
system would result.

More narrowly, before the government embraces any particular managed-trade policy it must consider the response
of its trading partners. The mere existence of a policy
instrument that could promote the desired economic goal of
capturing rents or overcoming market failure from positive
externalities does not mean that the policy would be effective
if our trading partners responded by adopting a policy of
managed trade in favor of their domestic producers. Those
possible responses have to be considered even if we are indifferent to the effect of any initiative on our trading
partners. Depending on the response, we may be worse off
if we engage in managed trade than if we refrain from doing
so. The possibility that other countries will react to any
managed-trade policy we adopt complicates the task of assessing
the impact of such a policy.

Difficulties

The difficulties associated with a policy of managed
trade have been illustrated by the current debate over the
government's role in the development of HDTV. HDTV is the
term for a broad range of computer and television technologies
that will produce sharper pictures on a wider-than-normal
television screen.(32) Supporters of government intervention
argue that there would be substantial spillovers (externalities) to other parts of the electronics industry, especially
to the semiconductor and computer industries, from the development of HDTV. The proponents of that view include the U.S.
Department of Commerce and the American Electronics Association, which has proposed a $1.35 billion program of federal
support for HDTV.

Advocates of supporting HDTV argue that it will be a
technology driver. Although it is easy to assert that there
will be all kinds of benefits from the development of HDTV,
it is more difficult to support those assertions. As a recent
draft report of the Congressional Budget Office makes clear,
there are some good reasons to doubt the claims that have
been made.

HDTV is unlikely to constitute a very large part of the
electronics industry, which makes it doubtful that its spill-overs will be large in comparison with those of other parts
of the electronics industry. In addition, although HDTV
would contain many high-technology components, those technologies have other uses, so it is unclear what role consumer
electronics would play in their development. Moreover, given
the globalization of manufacturing, it is far from certain
that domestic production of HDTV would substantially increase
the demand for domestic semiconductor production. U.S. firms
could dominate the HDTV market and still buy their semiconductors abroad.(33) The Congressional Budget Office concludes
that "it is unlikely that HDTV will play a pivotal role in
the competitiveness and technology development of the [electronics] sector as a whole."(34)

Thomas Gale Moore, a senior fellow at the Hoover Institution and a former member of the President's Council of
Economic Advisers, pointed out that because HDTV receivers
will be large, they almost certainly will be assembled in
the United States. However, regardless of the nationality
of the owner of the U.S. assembler, whether U.S. or foreign
semiconductors will be used will depend on the price and
quality of the chips. Moore also warned that artificially
fostering the HDTV industry would divert scarce and valuable
engineering resources from the computer industry, in which
U.S. firms are dominant.(35)

Thus, a convincing case for an interventionist trade
policy has yet to be made; advocates of such a policy have
yet to address the many difficulties it would entail.

New Argument against Managed Trade

The new international economics has produced not only a
new argument for managed trade but a new counterargument as
well. The premise of both arguments is that many markets
are characterized by imperfectly competitive behavior. Imperfectly competitive behavior implies that there are new
gains, above and beyond the normal ones found in perfectly
competitive markets, that can be realized from freer trade.
Those gains are of three kinds.

Freer trade can reduce price distortions faced by consumers by increasing the overall level of competition in a
domestic economy. Oligopolistic firms (firms operating in
industries with only a handful of competitors) may limit
their output in an effort to raise prices artificially and
increase their profits. Such practices obviously reduce the
well-being of consumers and the nation as a whole.(36) The
most powerful antidote to undesirable oligopolistic behavior
is the entry or potential entry of additional competitors,
and foreign competition benefits U.S. consumers just as surely
as new domestic competition would.

Freer trade can also eliminate the wasteful duplication
of firms' producing on too small a scale, which because of
fixed costs have inefficiently high average costs. The anti-competitive pricing of oligopolistic domestic firms encourages
new entry. If foreign competition is restricted, the new
entrants will be domestic firms. Devoting the economy's
resources to such high-cost production is inefficient. To
the extent that new entry imposes otherwise avoidable production costs, there is a loss to the domestic economy. By
reducing the market price, freer trade can discourage inefficient entry by domestic firms.

Finally, freer trade can reduce the rents realized by
foreign firms.(37) Restricting trade can lead to foreign
producers' forming cartels that charge oligopolistic prices
in the United States. Because profits, or rents, are transferred outside the United States, foreign cartels are even
worse than domestic ones. Freer trade in the form of increased
foreign competition can reduce the rents that accrue to foreign
firms.

The additional benefits from free trade are not just
theoretical; they have empirical support. A recent survey
of the empirical literature by J. David Richardson of the
University of Wisconsin concludes that freer trade creates
sizable increases in an economy's real income. According to
Richardson, trade liberalization produces substantial gains
in real income because it rationalizes industrial structure
and reduces noncompetitive pricing. Cases in which trade
liberalization reduces national income appear to be rare.
It thus appears that the gains to be derived from trade liberalization are even greater in the new environment than they
were in the classic environment.(38)

It is commonly thought that the existence of imperfectly
competitive markets strengthens the case for intervention and
weakens the case for free trade. As the new counterargument
demonstrates, the benefits from free trade are even larger
with imperfectly competitive markets. Thus, although a theoretical argument for a managed-trade policy can still be
made, the practical argument for free trade is stronger.

Conclusion

In theory, managed trade would entail government intervention only when it would be beneficial. In practice, however, policymakers would find it difficult to remain independent and base their decisions on economic considerations alone.
They would also find it difficult, if not impossible, to
know when federal government intervention was in the interest
of the nation, not just the affected industry, and what form
intervention should take. Krugman summarizes the argument
for rejecting managed trade:

If the potential gains from interventionist
trade policies were large, it would be hard to
argue against making some effort to realize
these gains. The thrust of the critique offered
above, however, is that the gains from intervention are limited by uncertainty about appropriate policies, by entry that dissipates
the gains, and by the general equilibrium effects
that insure that promoting one sector diverts
resources from others. The combination of
these factors limits the potential benefits of
sophisticated interventionism.
Once the expected gains from intervention
have been whittled down sufficiently, political
economy can be invoked as a reason to forgo
intervention altogether. Free trade can serve
as a focal point on which countries can agree
to avoid trade wars. It can also serve as a
simple principle with which to resist pressures
of special-interest politics. To abandon the
free-trade principle in pursuit of the gains
from sophisticated intervention could therefore
open the door to adverse political consequences
that would outweigh the potential gains.

It is possible, then, both to believe
that comparative advantage is an incomplete
model of trade and to believe that free trade
is nevertheless the right policy. In fact,
this is the position taken by most of the new
trade theorists themselves. So free trade is
not passe--but it is not what it once was.(39)

Even the most well intentioned government intervention
can wreak havoc on downstream industries and consumers, as
illustrated by the parable of the skunks and the snapping
turtles.(40) The story chronicles New Hampshire's efforts
to "assist" tourism and fishing, two of the state's largest
industries. When local merchants complained that tourists
and fishermen were traveling to Maine and Vermont to avoid
New Hampshire's skunks, the state government undertook an
aggressive skunk eradication program. An increasing number
of fishermen and tourists visited the fragrant shores of New
Hampshire's many lakes and rivers, and local merchants were
delighted.

Two years went by, and a rumor began to spread: the
fish had stopped biting in New Hampshire. The next summer
was a disaster for the fishing industry; the fish population
was badly depleted. Once again fishermen and tourists took
their gear and their business to neighboring states.

What had gone wrong was that there were fewer skunks,
the natural enemy of snapping turtles, to eat snapping turtle
eggs. The snapping turtle population had surged, and the
turtles were busily eating fish eggs. To make a long story
short, New Hampshire had to import a large number of skunks.
For several years New Hampshire imported and exported both
skunks and snapping turtles in an attempt to find the optimal
mix.

Managing trade is at least as difficult as managing
wildlife. Tinkering with either will always have unintended
consequences. Policymakers would thus be wise to recognize
that Mother Nature and the Invisible Hand make better managers
than do government officials.

Notes

(1) For a short but convincing defense of the multilateral
trading system, known as the General Agreement on Tariffs
and Trade (GATT), from which the United States has benefited
greatly, see Jagdish Bhagwati, "Let GATT Live," Wall Street
Journal, July 28, 1989, p. A10.

(7) Between 1980 and 1987 U.S. exports to Japan increased
by 33 percent, from $21 billion to $28 billion, and total U.S.
exports grew by less than 12 percent. Over the same period,
U.S. imports from Japan jumped more than 170 percent. See
Economic Report of the President, 1989, Table B-104.

(8) David Tarr, "A General Equilibrium Analysis of the Welfare
and Employment Effects of U.S. Quotas on Textiles, Autos,
and Steel," Bureau of Economics staff report to the Federal
Trade Commission, February 1989.

(9) Advisory Committee for Trade Policy and Negotiation,
Analysis of the U.S.-Japan Trade Problem, February 1989.

(10) Jagdish Bhagwati, Protectionism (Cambridge, Mass.: MIT
Press, 1988), p. 125. This tiny book is crammed with common
sense about international trade.

(16) See, for example, Labor-Industry Coalition for International Trade, White Paper on International Trade, June
1986, p. 10. Television is frequently included on the list
of declining elements of the U.S. electronics industry because
there is only one U.S.-owned television maker, Zenith. However, 20 companies manufacture color television receivers in
the United States. Thomas Gale Moore, "The Promise of High-Definition Television: The Hype and the Reality," Cato Institute Policy Analysis no. 123, August 30, 1989, pp. 8-9.

(18) That view was taken in a 1984 report by the New York
Stock Exchange, "U.S. International Competitiveness: Perception
and Reality," cited in Cohen and Zysman, p. 5.

(19) Value added per hour paid, a measure of productivity,
grew at 4.7 percent a year from 1981 through 1987, roughly
one and one-half times the postwar average and more than
three times the rate from 1973 through 1981. For comparison,
private business sector productivity grew at an annual rate
of 1.7 percent from 1981 through 1987. Economic Report of
the President, 1989, p. 57.

(23) Rent is a wage received by workers or a return on capital
above the resource's opportunity cost in other pursuits.
Rents are beneficial to the domestic economy because they
increase the nation's control over goods and services.

(25) If the purpose of a policy is to redistribute income or
accomplish some other end, such as promoting national security
or prestige, even at the cost of reducing income, its
justification is entirely different and noneconomic.

(26) It should be noted that the FTC staff report found no
support for the argument that protection of high-wage industries increases the average wage in the economy. In fact,
the report found a small decrease in the average wage. Tarr,
p. 4.

(28) For example, the owners of oil reserves experience a
windfall when the price of oil rises. New entrants who choose
to search for oil in response to higher prices, however,
will earn, on average, only a competitive rate of return.
In general, because the price mechanism signals additional
competitors to enter an industry when prices rise, there is
no need for the government to encourage even more entry.

(29) Simple linkages, such as the use of semiconductors to
build computers, do not imply externalities. Because a supplying industry can capture in profits the benefits of its
production to downstream users, there is no reason to expect
underinvestment in the upstream industry. See Lawrence, Can
America Compete? p. 99.

(30) Bhagwati, Protectionism, pp. 105-10.

(31) Robert Lawrence, "Lure of Trade Management," Financial
Times, March 9, 1989, p. 22. Anyone who believes the United
States should follow a managed-trade policy should ask if
there is a consensus in the United States in favor of sacrificing self-interest to strategic considerations, or if the
more likely result is that the politically powerful will get
the benefits of managed trade, regardless of the merits.

(32) The current U.S. television technology uses 525 lines
and has a 4:3 ratio of width to height. HDTV generally refers
to any television technology with over 1,000 lines and at
least a 5:3 ratio of width to height. According to some
estimates, an HDTV receiver will require a memory with associated semiconductors 30 times more powerful than that
found in today's personal computers. Moore, p. 1.

(33) Congressional Budget Office, "The Scope of the High-
Definition Television Market and Its Implications for Competitiveness," staff working paper, July 1989.

(34) Congressional Budget Office, p. 1.

(35) Moore, p. 12.

(36) The injury to the nation is measured by the standard
dead weight loss, which is directly proportional to the degree
that market price exceeds marginal cost.